Expand and Reform CBAM For the World

I have been writing about EU’s CBAM on my blog ever since I read about it in The Economist, so it came as a surprise to me that CBAM is to go into effect in October this year. I had in fact, written after the climate summit at Glasgow, that it was disappointing to read that CBAM had not even been discussed in detail at the conference. It’s not hard to see why that might be so: the way CBAM has been conceived by lawmakers in the EU, it is meant to use trade policy to effect carbon emissions reductions and climate change mitigation. It is trade policy first, and only later a climate change one.

Therefore, it is equally surprising to see think-tanks write about the greening potential of CBAM, while at the same time arguing for CBAM to comply with WTO regulations. In fact, it must first comply with WTO regulations and according to Europa, CBAM is already WTO compliant. This is fast work, indeed. Strange that the rest of the world hasn’t expressed their reservations about it, because the way CBAM exists in its current form, it is hugely protectionist to the detriment of international trading partners. CBAM will hurt EU trade with other countries, which EU needs badly right now, and also make imported products much more expensive, which EU countries don’t need right now.

The Europa taxation customs info section also mentions that both the EU Council and the European Parliament have signed the CBAM Regulation on May 10, 2023 and that the first phase of transition goes into effect on October 1, 2023. This is only a transition pilot phase, specific to most polluting industries such as iron and steel, aluminum, cement, fertilizer, electricity and hydrogen. The last one should have been oil and gas, I thought. And what about coal, which Germany is said to be using even now? Besides, CBAM now covers a wider scope than just carbon emissions, to include all greenhouse gases. Further, the site also says that importers of these goods have to report greenhouse gases embedded in their imports, without making financial payments or adjustments. Not very clear what they mean; is this only for the transitional phase?

From what this presentation and discussion on the greening potential of CBAM at Bruegel seems to indicate, CBAM seems to be a way to achieve a level playing field between EU countries and the rest of the world in the way carbon is priced. Therefore, they have set the carbon border tariff at the same price as determined by the carbon price in their own ETS. And they argue that therefore, because it mirrors the ETS pricing, it is not discriminatory and is WTO compliant. I find this to be a weak argument, because non-discriminatory pricing cannot be the only condition on which CBAM becomes WTO compliant. Further, EU may argue that because CBAM reflects the same price of carbon as the ETS, it is not inflationary. Finally, the entire thing seems to be a notional way of achieving carbon pricing parity, because of free allowances that make the carbon border tariff payable, only when free allowances are exhausted or by 2026, whichever is earlier. And then, there is also talk of export rebates given to domestic producers to compensate for the free allowances given to importers. I have my doubts on whether CBAM will achieve anything in its current form, and I believe that the EU should have reformed its own ETS by transitioning to a carbon tax.

Even if the full implementation of CBAM goes into force only on January 1, 2026, the transitional phase will already put pressure on all companies and countries outside the EU and exporting to EU, to comply by having to report embedded greenhouse gases in their exports, from October 1, 2023. This will have an immediate effect on global trade, including to and through EU, as also on prices. And because these are core sector industries on which CBAM is being applied first, it will increase commodity prices at least within the EU, which is the last thing anyone anywhere in the world wants right now.

It is precisely for this and other reasons that I thought that CBAM would be a more effective tool if it is made to work on a global scale, at least for all G20 countries. As I have written before, this would require CBAM to be rethought on the basis of sharing the burden of carbon emissions more equitably, given that so much of manufacturing is globalized, especially through global supply chains. In the revised CBAM scenario, companies (not merely importers) will have to report the carbon-intensity of their manufactured product and based on a particular formula that can be agreed upon by all G20 countries, pay a carbon tax on the traded part of their output. This also reflects in the making of a finished good, as the maker having to account for carbon-intensity of all imported inputs in assessing the carbon intensity of his final product which is exported, and paying a carbon border tax on it. To help companies bring down the carbon-intensity of their manufactured products, a slab structure comprising various levels of carbon-intensity and corresponding carbon border taxes to be paid can be worked out.

This can be the beginning of countries’ clean energy transition, by at least agreeing not to export or import carbon-intensive products, and by actually paying a price for it. By beginning, I mean that whether member countries have a domestic carbon tax or not, this shared carbon border tax will help them on their own journeys towards a less carbon-intensive future. And because all countries are part of this carbon border tax, it will not be seen as a protectionist measure to help certain countries, to keep exports out, or to prevent manufacturers from locating their factories elsewhere. Most important, it will reflect a more equitable sharing of the burden of reducing carbon emissions among all countries.

I thought I would raise this CBAM issue and write about it again, as India is hosting the G20 summits this year. And with the G20 Heads of Government Summit slated for September 2023 in Delhi, it doesn’t give us much time to discuss and debate CBAM more widely, before EU implements the transition pilot phase in October this year. I hope the Indian government will take the initiative on this one and impress upon EU as well as other G20 countries, that CBAM is an idea that needs to be expanded and revised for it to make more sense for the entire world. To that extent, perhaps India and G20 countries can request the EU to push the pilot phase to next year, when all countries can join it. And in the meantime, work on a formula for devising the carbon border tax as well as the slab structure for it through consultation and dialogue. Needless to say, the WTO ought to be part of these discussions as well and it must become part of WTO rules.

The way to achieve carbon emissions reduction and carbon-pricing parity between countries in a world where manufacturing and trade is globalized, if there is indeed such a genuine objective, is to work together with other countries and impose a reasonable carbon tax on traded merchandise. And enshrine this objective and agreement under WTO rules as well.

The EU going it alone with CBAM is a half-measure, even a notional one, that doesn’t even begin to address the carbon-emissions problem in its full gravity. Perhaps India and other G20 countries can begin a new dialogue with the EU to make this laudable goal of reducing carbon emissions a workable reality.  

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